Why Broadcom Wants To Buy Qualcomm

Semiconductor company Broadcom made an unsolicited $105 billion bid for wireless technology behemoth Qualcomm on Monday, in what could shape up to be the biggest-ever deal in the technology space. Broadcom’s offer of $70 per share ($60 in cash and $10 per share in Broadcom stock) values Qualcomm at a premium of about 28% over its closing price before reports of a deal emerged. The deal comes at a time when Qualcomm’s stock has been underperforming, amid a spate of lawsuits from regulators in countries ranging from Korea to the United States, as well as its litigation with its largest customer Apple, making it a particularly attractive time for Broadcom to acquire the company.

Broadcom’s management has a solid track record of financial engineering and cost-cutting, and it’s possible that it sees scope to significantly cut Qualcomm’s costs. Broadcom, as it stands, is a product of a deal that closed in 2015, with Avago Technologies buying larger peer Broadcom, with the core rationale being that Broadcom’s cost base could be reined in. Avago had operating margins of ~38%, while Broadcom’s margins stood at about 24% before that deal closed. The combined entity has now largely succeeded with cost-cutting, with operating margins coming in at a strong 46% in the most recent quarter. Qualcomm also likely has scope to reduce its costs. Although its patent licensing segment has thick margins (estimated pre-tax earningsof 68% to 72% for Q1’18) the chip division, which accounts for a bulk of revenues, is projected to have EBT margins of just 18% to 20%, leaving scope for improvement if the company shuts smaller and underperforming product lines. There could be revenue synergies as well. If a deal goes through, the joint entity would be a one-stop shop for smartphone vendors, selling everything from modems and application processors to Wi-Fi and GPS chips.

The Odds Of A Deal Going Through Remain Questionable

While there are certainly many benefits of a deal, the probability that it will go through doesn’t seem especially high at this point. Firstly, the Financial Times reports that Qualcomm’s board is likely to reject the unsolicited offer, as it believes that the offer price significantly undervalues the company, given that the stock traded at roughly these levels just about a year ago. Moreover, the deal could be financially risky for Broadcom, as the net debt of the combined company could stand at upwards of $100 billion, factoring in Qualcomm’s existing debt and the debt it will issue to fund its planned purchase of NXP Semiconductors. Broadcom is projecting EBITDA of roughly $23 billion for the joint entity, including cost savings, implying a debt to EBITDA multiple of more than 4x, which is relatively high for the technology industry. The deal could also face intense regulatory scrutiny. While Qualcomm has run into multiple anti-trust issues relating to its wireless patent licensing business, the cases could mount. The two companies have somewhat complementary product lines and are leaders in the Wi-Fi and Bluetooth space, making regulators question the combined market power of the company.